DTC companies cut out the middle man, AKA department stores, by selling their products directly to consumers. Margins are the basis for pricing in today’s current DTC climate. However, product pricing requires more than a mathematical equation and your pricing strategy has implications for your business that go beyond just your bottom line. If you set your prices too high, you will push away potential customers but if you set them too low, you will have a difficult time being profitable. Before we dive into the most popular product pricing strategies, let’s look at key variables to think about before setting your prices.
The most obvious and most important consideration when pricing your product is the cost of getting your product to market. Most DTC companies attract customers by setting their prices lower than traditional retail prices but higher than wholesale prices.
However, being financially informed is vital for setting product prices and many new business owners misunderstand margins. Product margin refers to the markup of a specific product. It’s important to note product margins do not account for factors like fees, shipping, discounts and returns. Consequently, a 50% product margin can easily be reduced to a 25% gross margin. A business operating with a low gross margin will not be able to remain profitable after factoring in overhead and operational costs. According to Forbes retail expert Richard Kestenbaum, for a DTC company to be successful they should have a gross margin of at least 50%.
Compile a list of all your expenses to determine how much you must make on each sale for your business to remain profitable. To determine true operational cost, you need to factor in all expenses, not just the cost of goods sold (COGS).
Other expenses to consider include:
- Production time
- Credit card processing fees
- Advertising and marketing expenses
- Insurance costs
- Licence and regulatory fees
- Maintenance and repair costs
- Equipment rentals
- Office expenses and supplies
- Utility expenses
When setting your prices, you need to consider where you will be selling your products. If you are selling on a marketplace, you must take into account the customer base, fee requirements and pricing and competition in your product category. Some platforms like Wish, are geared toward deal seekers, while Amazon customers may be willing to spend more to receive the product faster.
Additionally, you need to understand the rules and regulations of the platform you are selling on. Some platforms have price parity clauses while other platforms, like Etsy, have rules against sellers coordinating prices.
As mentioned above it is important to take into consideration the type of customer your product is aimed at. Before setting your prices, you need to determine what your target customer is willing to pay for a product like yours through market research.
If there is a lot of market competition in your product category, it is important to set your prices strategically. Look at average prices in your product category to make sure you remain competitive. You can also use tools like Jungle Scout and Price2Spy, to get a more thorough understanding of competitor pricing and demand.
As discussed above, it is important to look at similar products when setting your prices. However, you should also look at what sets your products apart. If you offer your customers something different from the competition, it can incentivize them to choose your product over cheaper alternatives. This can be a product feature or a business related offer like fast shipping, free returns or an extended warranty. According to the 2021 ACA Study, 52% of Americans will pay more if they know they will receive great customer service and 70% of customers will pay more for convenient service.
Now that we have discussed some key considerations when setting your prices, let’s look at the most used product pricing strategies. Remember, there is no perfect way to set prices. Try out different strategies and experiment to find out which strategies work best for your business.
Also known as mark-up pricing, using this strategy the selling price is determined by adding a fixed percentage on top of the production cost for each unit. This strategy ensures you remain profitable; however, it doesn’t take into account external factors like competitor pricing and consumer demand.
To set your prices using Keystone Pricing, you simply double the wholesale cost. This strategy is often a good place to start, however based on your industry you may have to adjust your prices to account for factors like low turnover, shipping costs and competitor pricing.
Competition based pricing, as its name suggests, is the practice of setting your prices based on the prices of competitor products. This strategy is often used in saturated markets.
With a price penetration strategy, products are priced low to entice customers and gain as much market share as possible. This strategy is most effective for low-cost items where price is a driving factor in a customer’s product selection, for example, household goods. A disadvantage of this strategy is that it is often not a viable long-term pricing strategy, and when prices begin to gradually increase, customers may become dissatisfied.
The goal of a premium pricing strategy is to create the perception that your products are of high quality by setting your prices higher than competitors. The benefits of this strategy include high profit margins and improved brand value. However, this strategy will also limit market opportunity as you are pricing out segments of the market. Your product must also have a unique selling point that justifies the high price tag to potential customers.
Using value-based pricing, you set prices that reflect what customers are willing to pay for a product based on the consumer's perceived value of the product or service in question.This strategy works best for companies that offer unique or highly valuable products. An example of this strategy is luxury designer goods. The price reflects the value assigned to the brand, not the material cost of manufacturing the product.
Using a price skimming strategy, the retailer sets a high initial price and gradually decreases the price over time. Setting a high initial price maximises profits while initial consumer demand is high, and as the price decreases, you reach more segments of the market. This strategy is most commonly used when a new type of product is released and competitors have not yet entered the market. An example of this is when Apple launches a new iPhone model, they set the initial price high and lower it over time as competitors launch rival products.
Discount pricing creates a sense of urgency and drives sales by temporarily marking down the price of a product. This is a particularly effective strategy for out-of-season and slow-moving goods. Although discount pricing brings in new customers, discounted customers often have a higher church rate.
Bundle pricing is the practice of grouping several products together to sell at a single price. Customers are motivated to purchase the bundle because the individual items are priced at a discount. This strategy is an effective way to increase your average order value and it encourages customers to try more than one of your products.
There is no one-size-fits-all pricing strategy. Determining which strategies will work best for your business will depend on what you're selling, supply, demand, how long you have been in business, and will change over time. With some research and experimentation, you can find the approach that works best for your business.
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